THE VISIBILITY CORPORATION (TVC)

DELVIGNE Anne-Charlotte Click to edit Master subtitle style NGUYEN Linh NICOSIA Calogero VANCUTSEM Sbastien YANOGO W. Mickael ZENNER Gilbert

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CONTENT

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INTRODUCTION

Directors of The Visibility Corporation (TVC) are meeting to discuss whether the CEO should be offered a new contract. The CEO could have engaged in aggressive accounting system (known as earning management).
6/25/12 Our objective is to examine the financial report (in

Question 1. What is meant by the term earnings management? Give an example.

Earnings Management
Strategy used by the management of the company to manipulate the companys earning and match a predeterminated target (i.e profit for the year did not fall by more than 510%).

Objectives: To influence the perception of stakeholders about the firms general economic performance. Influence certain outcomes that depends on reported
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Question 1. What is meant by the term earnings management? Give an example.

Earnings Management
Strategy used by the management of the company to manipulate the companys earning and match a predeterminated target (i.e profit for the year did not fall by more than 510%).

Objectives: To influence the perception of stakeholders about the firms general economic performance. Influence certain outcomes that depends on reported
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Question 1. What is meant by the term earnings management? Give an example.

Example of earnings management

There are four main ways managers can manage earnings: 1) Unsuitable revenue recognition. 2) Inappropriate accruals and estimation of liabilities. 3) Excessive provisions and generous reserve accounting. 4) Intentional minor breaches of financial reporting requirements.

Suppose a business has an investment of 1 million at historic cost which can easily be sold for 3 million, being the current 6/25/12 value. The managers of the business are free to choose in

Question 2 : Describe how available-for-sale investments can be used for earnings management under IFRS ( IAS No. 39)

Recall about the bookkeeping of the available-for-sale :

Available-for-sale investments are measured at fair value in the balance sheet.

The change in the fair value susbequent to acquisition is recognized directly in equity.

Once AFS is sold, the amount previously reported in 6/25/12 equity is then recycled out of equity and reported in

Question 2 : Describe how available-for-sale investments can be used for earnings management under IFRS ( IAS No. 39)

The manager can arrange when to recognize the gains or losses of these available-for-sale investments by selling them in selective timing.

If the income statement need a boost: Sell AFS assets. Profits will be reported to the income statement. If the income statement looks good: Keep AFS assets and delay any recognition until losses occur.

Earnings management can be conducted by the manipulation of fair value it can be over-estimated in case of profit or underestimated in case of losses
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Question 4-a. Are available-for-sale investments reported in the balance sheet at fair value or cost?

Available-for-sale investments are reported at fair value.

Selected Notes to the Financial Statements (1B) Investments [] Available-for-sale investments are stated at fair value, with any resultant gain or loss being initially recognized in equity. The amount is recognized in the income statement in the period the available-for-sale investments are sold []. 6/25/12

Question 4-b. How much profit (loss) from available-for-sale investments is reported in profit for the year?

Income Statement:

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Question 4-b. How much profit (loss) from available-for-sale investments is reported in profit for the year?

A profit of $15 million is reported in the Income Statement.

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Question 4-c. How much profit (loss) from available-for-sale investments is reported in total recognized income and expense for the year?

Unrealized losses of $ 35 million was reported in the Total recognized income and expense for the year.

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Question 4-c. How much profit (loss) from available-for-sale investments is reported in total recognized income and expense for the year?

Total recognized income and 172 = expense 117 = + 55 Profit + Net income recognized in equity
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Recycled profit of $ 15 million

Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.

AFL investments information given in the financial statements:

Balance Sheet Cash Flow Statement Statement of Changes in Equity
AFL investments at 30 June 20X5: $ 30 Purchase of AFL investments: $ 40 Proceeds from AFL investments: $ 20 Unrealized losses: $ 35. Profit reclassified to Income Statement: $ 15 (Other income).

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Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.
Year 20X4 Accounts and Explanation Available-for-sale assets Reserves (Unrealized gain) Debit Credit 15 15

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Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.
Year 20X4 Accounts and Explanation Available-for-sale assets Reserves (Unrealized gain) Reported in Cash Flow Statement. 20X5 Available-for-sale assets Cash Debit Credit 15 40 15 40

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Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.
Year 20X4 Accounts and Explanation Available-for-sale assets Reserves (Unrealized gain) Debit Credit 15 20X5 Available-for-sale assets Cash Reported in Cash Flow Statement Cash Reserves Available-for-sale assets Profit 40 20 15 15 40 20 15

20X5

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Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.
Year 20X4 Accounts and Explanation Available-for-sale assets Reserves (Unrealized gain) Debit Credit 15 20X5 Available-for-sale assets Cash Reclassified to the Income Statement. Cash Reserves Available-for-sale assets Profit 40 20 15 15 40 20 15

20X5

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Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.
Year 20X4 Accounts and Explanation Available-for-sale assets Reserves (Unrealized gain) Debit Credit 15 20X5 Available-for-sale assets Cash 40 Cash Reserves Available-for-sale assets Profit 20 15 20X5 Reserves (Unrealized losses) Available-for-sale assets6/25/12 35 15 40 20 15 35

20X5

Question 4-d. Explain your answer to parts (b) and (c) above and the impact on current and future profits.

Impact on current and future profits: Current profit is a gain of $ 15 million. If the company decide to sell the AFL assets, the unrealized losses will become realized and reported in the Income statement.

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Question 4-e. What was the amount of availablefor-sale investments held at 30 June 20X4?
Year Accounts and Explanation Available-for-sale assets Reserves (Unrealized gain) Total available-for-sale assets at 30 June 20X4: X. Debit Credit 15 40 20 15 35 15 40 20 15 35

Assume X (million $) is the value of AFL investments at 30 June 20X4.

20X4

X = 30 + 15 = 45.

20X5

Available-for-sale assets Cash Total available-for-sale assets after purchase: X + 40. Cash Reserves Available-for-sale assets Profit Total available-for-sale assets: X + 40 - 20 = X + 20. Reserves (Unrealized losses) Available-for-sale assets 6/25/12 Total available-for-sale assets at 30 June 20X5: X + 20 - 35 = X - 15.

20X5

20X5

Question 5. Based on your answers to Question 4, do you think TVCs executives have engaged in earnings management? Give reasons for your answer, and identify any additional information you require to reach a firm conclusion

We believe the firm could have engaged in earnings management but it is not possible to determine from the information given.

Additional information required:

Criteria for evaluating performance (i.e. earnings must not exceed 10%): Possible incentives for earnings management. Accounting policies of TVC: Who is responsible for preparing and auditing the financial statements? Information of transactions involving AFL investments: When and how were the AFL investments sold? 6/25/12 System of fair-value measurements: How was fair-

Question 6: Should the performance be assessed on profit or changes in equity, as suggested by David, or on some other measure? Why?

Both measures are important. Profit: To know the performance of annual business cycle. Changes in equity: To know the financial positions of the firms and how the resources are used. Another measure is ratio analysis: Calculating ratios based on data given by financial statements. 6/25/12

Question 7. What (if any) further information would you like to have before deciding whether to renew PBs contract? What decision do you think Ann, Phil, and David should reach?

The information given is not sufficient to decide whether to renew PBs contract. It is important to find out whether PB has engaged in earnings management, and re-evaluate the performance of the company. Additional information required: Reconciliation of changes in equity: Ratio of profit from core operations to profit from secondary sources. Ratio analysis (benchmarked with previous years, or 6/25/12 competitors in the industry).

CONCLUSION

Through the case study, we have explored the concept of earnings management, available-for-sale investments and International Financial Reporting Standards (IFRS). It is possible that TVCs executives have engaged in earnings management, however the information given is not sufficient to evaluate this. Making financial reports more informative for users through the use of accounting judgment should not be considered as earnings management. 6/25/12

Thank you for your attention!

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